FIN 634 Exam 1 Part 2

Fall 1999

True/False - 2 Points per Question

1. Using the Investment Vehicle Model, the goal of the firm is to maximize its growth rate.

2. Majority voting makes it easier for a minority-shareholder group to elect one or more representatives to the company's Board of Directors.

3. One of the drawbacks of profit maximization as a management goal is that it does not take risk into consideration.

4. The responsibilities of the Controller include auditing, management accounting, and financial reporting.

5. Financial intermediaries facilitate the purchasing and selling of financial securities for their clients.

6. In majority voting, each share of stock carries one vote and a shareholder can combine votes and cast them all for a single candidate for the Board of Directors.

7. The preemptive right of ownership give the shareholders the right to be the first to sell their shares in the event of a takeover.

8. The "real" rate of interest is the rate that an average investor would require on an investment in the absence of risk and inflation.

9. A good proxy for the current real rate of interest is the market rate on 30-day US Treasury Bills.

10. For a given investment and a given investor, if the expected return exceeds the required return then the investment should be purchased since it will be a net creator of value.

11. The higher the risk of an investment, the higher will be its real rate of interest - other things equal.

12. Since international accounting standards are fairly consistent, financial statements are generally consistent from one country to another.

13. The price at which stocks are bought and sold in the financial markets is known as their book value.

14. The balance sheet for a company shows the current market values of both the assets and the claims against those assets.

15. While the notes to the financial statements and management's discussion in the financial statements sometimes contain interesting information, that information is usually not very useful.

16. For well-established companies that have been in existence for many years, we should expect the market value and book value of assets to be approximately equal.

17. The Subchapter S corporation permits certain businesses to have their income taxed only as personal income to the owners, thereby eliminating the double taxation of earnings that is a problem in regular corporations.

18. Dividend payments to shareholders are a tax-deductible expense for a corporation.

19. Most financial transactions are "zero sum games".

20. An option that permits its owner to purchase an asset at a particular future point in time for a predetermined price is called a "put" option.

21. Since common stockholders have limited liability, common stock can be thought of as a special form of option.

22. Most people will accept a lower expected rate of return in exchange for a reduction in risk.

23. A graphical depiction of the term structure of interest rates is the yield curve.

24. An investor who is risk averse would only be willing to invest in risk-free securities.

25. Arbitrage is the act of simultaneously buying and selling an asset in different markets in order to provide an instant and riskless profit.

Multiple Choice - 2 points per question

Select the single best answer of each question and record you answer on your answer sheet.

1. The major differences between profit maximization and shareholder wealth maximization as goals for a company are:

a. Risk and timing considerations
b. Shareholder voting considerations
c. Agency considerations
d. Stakeholder considerations
e. More than one of the above.

2. A contract that is dependent upon the value of some other asset or a particular occurrence is:

a. an explicit contract
b. an implicit contract
c. a contingent contract
d. an incontinent contract
e. None of the above

3. In which of the following forms of business ownership is ownership accompanied by limited liability?

a. A sole proprietorship
b. A general partnership
c. A corporation
d. More than one of the above.
e. None of the above.

4. Interest rate risk for bonds:

a. increases as the term to maturity increases.
b. increases as the term to maturity decreases.
c. is not affected by the term to maturity.
d. more than one of the above.
e. none of the above.

5. Which of the following is not a money market instrument?

a. Treasury bills
b. Certificates of deposit (CD's)
c. Treasury bonds
d. Bankers' acceptances
e. None of the above.

6. The required rate of return on a security is affected by

a. its risk
b. its term to maturity
c. its taxability
d. two of the above
e. all of the above

7. Market prices for financial assets that are traded regularly in the capital markets reflect all available information and adjust fully and quickly to new information. This statement reflects

a. the principle of the risk/return trade-off
b. the principle of arbitrage investing
c. the principle of monopoly advantage
d. the principle of capital market efficiency
e. none of the above

8. Investments with Net Present Value (NPV) = 0

a. give the investor no profits
b. are unacceptable
c. do not adequately compensate the investor for risk
d. more than one of the above
e. none of the above

9. Other things equal, the value of an investment increases

a. as the required return increases
b. as the expected return increases
c. as the risk of the investment increases
d. more than one of the above
e. none of the above

10. For any bond, if the coupon rate is greater than the yield to maturity then the bond will

a. sell at a premium
b. sell at a discount
c. have low risk
d. more than one of the above
e. none of the above

Problems - Points as marked

No work = No credit

1. Suppose a government bond is listed today in the Wall Street Journal as shown below:

Ask Rate = 9.35
Type = Sept 14
Bid = 102:01
Ask = 102:08

(Today is Sept 14, 1999)

The next coupon payment is due in exactly 6 months. The bond pays semiannual interest and matures on September 23 of its terminal year. (Today is September 22, 1999)

a. Compute the Yield to Maturity on the bond.

[10] Answer: _________________

b. Suppose you purchase this bond today for the listed price and hold it for five years. At the time that you sell it, suppose that the general level of interest rates has increased by three percentage points from what it was when you purchased the bond. Under these conditions, what will be your average annual holding period return on this investment? Be precise to 2 decimal places: xx.xx% for example.

[5] Answer: __________________

2. Suppose you are considering whether or not to purchase shares of stock for the ABD Corporation. You expect the next annual dividend to be $3.50 per share, and you expect that it will be a full year before the next dividend is paid. The required return is 14% and the expected constant annual dividend growth rate is 5%. What should be the market price for this stock?

[5] Answer: ________________

3. You are considering purchasing the stock in a relatively new company with high growth potential. You estimate that the company will not pay any dividend for the next five years, but will pay a $0.25 annual dividend per share beginning five years from now and that dividends and earnings will grow at a relatively constant rate g from then on. If your required annual rate of return on this stock is 12% and the market price for this stock is $4.50 today, what is the minimum expected value of g that would make you want to purchase this stock (assuming you are a rational investor)? Be precise to two decimal places: xx.xx% for example.

[5] Answer: _________________

Answers:

1=F, 2=F, 3=T, 4=T, 5=F, 6=F, 7=F, 8=T, 9=F, 10=T, 11=F, 12=F, 13=F, 14=F, 15=F, 16=F, 17=T, 18=F, 19=T, 20=F, 21=T, 22=T, 23=T, 24=F, 25=T, 26=A, 27=C, 28=C, 29=A, 30=C, 31=E, 32=D, 33=E, 34=B, 25=A

Problem 1: 9.07% 6.11%

Problem 2: $38.89

Problem 3: 8.47%